Financial markets are humbling.
After spending forty-eight years working in the industry, one would think I
would have learned some, if not many, of the answers. Not so. In my late teens,
I met the president of a regional brokerage firm based in Boston. He told me
that he had been in the business for several years and claimed he knew less
each year. That is familiar territory. Financial markets are akin to
discoveries about space. Just as boundaries to the latter keep expanding,
complexities to the former become more ubiquitous. Just when we think we know
the answer, something else gets added to the mix.

One ingredient this year is the
campaign for President and the possible nominees. A recent Barron’s article spoke to the “Bernie and Donald factors.” They
included a chart which contrasted the spike in their respective polls,
beginning late last year, with a collapse in the S&P 500. Coincidence? I
don’t know. Isolationism is troublesome to markets. While neither man campaigns
as an isolationist, they both advocate policies that lead that way. Mr. Trump
talks of imposing tariffs on goods imported from China. Senator Sanders
recently stated: “Unfettered free trade has been a disaster for working
Americans.” While the odds that either man will win the Presidency may not be high,
it is impossible to avoid the fact that the popularity of both reflect the thinking
of millions of Americans. Voters should not ignore the positive contributions
that free trade and globalization have brought to man’s well being. To the
extent the policies of Mr. Trump and Senator Sanders have economic
consequences, they will be reflected in financial markets.

Politics and financial markets
are intertwined. Government’s role should be to set rules. Business should play
the best it can within those rules, to the advantage of its owners, employees,
customers and communities. Economies work best when free markets set prices and
determine goods and services to be sold. There will always be risks. Creative
destruction, an economic phenomena popularized by Joseph Schumpeter seventy
years ago, destroys businesses that don’t adapt. While painful, change is
necessary for progress. Cronyism is birthed when rules are established that
serve to benefit an old (or favored) industry over a new entry. Consider the
experiences today of Uber, Airbnb and crowdfunding.

Politicians are in the business
of re-election. They do not necessarily operate in the long-term best interest of
their constituents. Like us, their time horizons have shrunk – theirs to the
next election. Businesses must have longer horizons. It may take a decade or
more to recover the costs of a new manufacturing plant, oil well, mine or
smelter. A fiduciarily responsible CEO must be confident of the future. He must
believe government’s tax policies, rules and regulations won’t harm his
business. He must be convinced that markets, foreign and domestic, will be
open. Uncertainty breeds inaction. In a recent Wall Street Journal article, David Malpass noted out that total
U.S. credit has grown by only 20% over the past five years, versus an average
of at least 40% over previous recoveries. “To make matters worse,” he added,
“80% of the increase went to government and corporate bonds, leaving only 20%
for the rest of the economy.” Again, consequences are evident: According to a
Gallop study, based on U.S. Census data, more small businesses in the U.S. are
closing than opening, the first time that has happened since measurements
began.

Over the past few years, the
government agency that has had the biggest impact on financial markets is the
Federal Reserve. This dates back to the financial crisis. The Federal Reserve
can act more quickly than Congress. In 2008 they did, with an assist from
Treasury and to the benefit of us all. In the subsequent seven years, however,
their effect has been more questionable. Japan, over the past two decades, is
proof that more than monetary policy is needed to perpetuate economic growth.
Keeping Fed Fund rates at essentially zero in the U.S. has been good for
financial assets (with the notable exception of savings accounts), but not for
business investment, the economy, or even from preventing “too big to fail” banks
from becoming even bigger. There are 25% fewer banks today than eight years
ago, and the five largest banks control almost 50% of the $15 trillion in assets
owned by banks. In 1990, the five biggest banks controlled 10% of banking
assets. Negative rates should make people nervous. As the Bank Credit Analysis recently put it: “Negative interest rates do
not generate growth; they destroy growth because they destroy capital.”

The reason we came to rely on the
Federal Reserve was because the President and Congress refused to provide
fiscal relief through a reformed tax code and more effective (and less
protective) regulation. The clue that something was wrong was when President
Obama ignored the findings of the National Commission on Fiscal Responsibility
and Reform in 2010, a bi-partisan commission headed by Alan Simpson and Erskine
Bowles that he had established a year earlier. Congress never addressed reform.
The consequence: The Fed became the only game in town. And now central banks
are running out of options.

But back to financial markets.
“Mr. Market,” as Martin Wolf recently wrote in the Financial Times, “is subject to huge mood swings.” Stock prices
reflect more than just revenues and profitability. They respond to behavior and
confidence. There are those like Robert Shiller whose cyclically-adjusted price-earnings
ratio concludes that current market levels have only been exceeded by those
that peaked in 1929 and 2000. I am not smart enough to debate Professor
Shiller, but I believe it is worth noting that ten-year compounded annual returns
for the Dow Jones Industrial Averages (DJIA) are quite different today than
they were in 1929 and 2000. In 1929, those ten-year returns averaged 11.9
percent; in 2000, 16.0 percent. When the DJIA reached its interim high last
June 23rd, the ten-year compounded annual return was 5.9 percent. Today
that ten-year return is 4.1 percent It is okay to be bearish, but perspective
is needed.

A financial market that has been in bull mode for thirty-five
years is the one for U.S. Treasuries. The yield on the U.S. 10-Year Treasury
has fallen from 15.8% in 1981 to 1.7% today. Can rates move lower? Of course.
Will they? I don’t know, but caveat
emptor would seem to apply.

Assessing markets is difficult,
not just because of the complexities of algorithms and mathematical formulas,
but because markets also reflect human behavior – the nuances within each of us.
As well, market participants confront myriad and conflicting government
policies. Like baseball, there are statistics for everything in economics and
markets. One can “prove” anything one wants. Person ‘A’ looks at a series of
numbers and claim they mean X. Person ‘B’ draws the opposite conclusion. Norman
Augustine, a businessman who served as Under Secretary of the Army from 1975 to
1977, once said: “if stock market experts were so expert, they would be buying
stock, not selling advice.”

Age has few benefits, but one is
perspective. It is based on one’s own experiences and from reading history,
biographies and fiction – novels that deal with the human psyche. We know that
tomorrow will not be “déjà vu all over again,” for history never repeats,
though it rhymes, as Mark Twain allegedly said. We learn that not all questions
have clear-cut answers, that events and individuals are unique, but we hope to
have the wisdom to understand that human behavior is subject to emotions that
are eternal. What history does say is that over the long term stocks have done
well, and that investing is less risky than trading or market timing.

Tuesday, February 16, 2016

“Democracy and Socialism have nothing in
common but one word, equality. But notice the difference:

While
democracy seeks equality in liberty, socialism seeks equality in restraint and
servitude.

Alexis
de Tocqueville (1805-1859)

“Free stuff” is an aphrodisiac;
it is like honey to a bear – who can forget the image of Pooh stuck head-first
into a tree, bees swarming about him. It was why Odysseus had his men lash him
to the mast as they approached the island of the Sirens. It appeals to the
emotions, not the intellect. Listening to Bernie Sanders speak after trouncing
Hillary Clinton in New Hampshire last week, it was easy to be swept away with
his promises of free stuff – healthcare and college – all with the illusion
this would solve unfairness and inequality. No discussion of the cost or how it
would be financed, other than to raise taxes on Wall Street moguls. No mention
of the decline in cultural and moral habits, like marriage, religion and work
habits, that accompanied the rise in entitlements. It is not just the words; it
is the way they are said.

Those who are duped with promises
of “free stuff” ignore the simple fact that everything has a cost. Mr. Sanders’
admirers are asked to reject the critical concept underlying our history, which
is the opportunity to succeed. No government can guarantee individual success,
but ours does provide equality of opportunity and equality before the law,
without regard to class, race or religion. Our government was created to
protect us from the threat of kings and oppressors. It was based on the notion
that our rights are God, not man, given. The Constitution provided us the
freedom to think, speak, assemble and pray as we like. It enacted laws that
protect us and our property from unlawful imprisonment and seizure. It promised
that we would be judged by juries of our peers. America’s democracy recognizes
inherent differences in individuals, as well as culture and heritages – that we
are (and always have been and always will be) a nation of immigrants tossed in
a cauldron, but maintaining our individual identities. American culture was
based on pluralism, not multiculturalism. We are individuals, not cattle to be
placed in pens convenient for politicians focused on group solutions to group
problems. We are meant to be unified, not divided. The American meaning of
liberty was never based on the promise of equality of outcomes – something that
can never be delivered.

The cradle-to-grave care that Mr.
Sanders feels is our due is enticing, especially to the naïve, those without
aspiration and to those ignorant of our history. The fact that we cannot afford
entitlements already promised, however, should give pause to those who believe
that the riches of the one percent will be available for the the ninety-nine
percent. The argument is made that Socialism has worked in some West European
countries. But those countries are largely homogeneous, and the influx of
refugees from the Middle East and North Africa is testing whether those systems
will still function. The United States, in contrast, is an amalgamation of
people from all over the world. It is our strength, but it is also one subject
to abuse by politicians who choose to divide so as to conquer. They prefer
compartmentalizing the electorate; it is easier to focus on specific promises
to groups: the young or elderly, women, gays, Blacks or Hispanics than to
discuss broad concepts like freedom, opportunity and individual responsibility
that are pertinent to us all. We should, as well, not forget that Socialism has,
at times, devolved into autocracies. Both Communism and Fascism were birthed
under the promise of equality, fairness and socialistic solutions.

Populist politics, whether from
the Right or Left, lead to authoritarianism. They involve finding someone to
blame for society’s problems. Individuals or groups are singled out as
responsible for whatever ills have befallen a nation and its people. Easily
identifiable groups are vilified. For Fascists and Nazis, it was Jews and
non-Aryans. For Communists, it was the aristocracy, free-holding serfs and
Jews. For Donald Trump, it is foreigners; for Bernie Sanders (and others on the
far Left), it is Wall Street and the “one percent.”

Extremism rises when dissatisfaction
is high and expectations low. Mr. Obama takes credit for the fact that our
economy is the fastest growing of the developed nations, that twelve million or
so jobs have been added and that unemployment is below five percent. But he
shuns the fact that developed nations have struggled in this economy and that
about eight million jobs in the United States were lost between 2007 and 2009. He
never mentions that this recovery has been the slowest in post-War history. He
avoids mentioning the millions of people who have abandoned the workforce. The
labor force participation, at 62.7%, is as low as it has been since the 1970s. The
gap between unemployment for African-Americans and Whites, at the end of the
third quarter 2015, was the highest in fifteen years. Wage gains have been nil.
The most negatively affected sectors of the demographics are the poor and
minorities, those very people Mr. Obama promised to help. While about three and
a half million Americans reach retirement age each year, roughly four million
turn eighteen.An economy needs to
absorb the natural growth in its population.

But this stagnation (and worse)
for growing numbers of America’s middle class people pre-dates the Obama
Administration. “The real family income of people in the bottom half of the
income distribution,” according to Charles Murray writing in the weekend’s
edition of the Wall Street Journal, “hasn’t increased since the late 1960s.”
Ironically, but importantly, the slowdown in family incomes for the bottom half
of Americans coincided with the increase in entitlements and the decline in
family formations. Is there a correlation? I am not a social scientist, but the
possibility cannot be dismissed. With Mr. Sanders, we would get are more of the
same. History provides no support to suggest his solutions will work.

In fact, history suggests a
different path. Democratic, free market capitalism has been the strongest force
for good the world has ever known. Arthur Brooks, president of the American Enterprise
Institute, recently wrote that free market capitalism has moved more people out
of poverty – 700 million, according to his estimate over almost 200 years –
than any other system. One has to look no further than Cuba, or as far away as
China, to understand the truth of his message. In his book, The Great Surge, Steven Radelet,
professor at Georgetown University, noted that the number of developing
countries, over the past twenty-five years, that have seen annual economic
growth exceed two percent has risen from 21 to 71. That has led to a doubling
of per capita income for millions of people. What triggered the surge? Mr.
Radelet writes that it was the collapse of the Soviet Union and the
discrediting of Marxist-Leninism

Democracy is not perfect and
neither is the United States. Nevertheless, with its laws, institutions and respect
for human endeavor, our system has allowed us to become wealthy, as a nation
and individually. It is a system where people are free to make choices, to
succeed or to fail. The combination of free market capitalism and democracy
have allowed us to be the most generous nation on earth, with beneficiaries
being libraries, hospitals, universities, museums, symphonies, etc.,
institutions that have enhanced life for everyone. That is not to minimize the
importance of safety nets; for we all know that there are are those who for
reasons of age, infirmities, prejudice and misfortune cannot fend adequately
for themselves.

Taxes and regulation, while
necessary for government to function and to keep people safe and competition
fair, act as governors on economic growth. The conundrum for government is to
find the right balance. When no rules are applied anarchy and economic
free-for-alls result. When they are applied too rigorously economic growth is
impacted. Mr. Sanders’ socialist policies, which avoid mention of positive
character traits like work, marriage or faith, risk slowing further an already
anemic economic recovery.

“Stuff” is not free. If its price
is not determined in dollars, its cost will be measured in freedoms lost.

Monday, February 8, 2016

Will he, or won’t
he? That is, will Michael Bloomberg decide on an independent run for the
Presidency, will Democrats tap him, or will he stay home? A decision must be
made reasonably soon, if he wants to get on the ballot in all fifty states. A
couple of weeks ago the New York Times published a front page article,
“Bloomberg, Sensing an Opening, Revisits a Potential White House Run.” They
noted he had tasked his advisors with determining the merits of an independent
candidacy.

Mr. Bloomberg, a
three-term Mayor of the City of New York, is said to be motivated by the possibility
(remote as it may seem) of voters having a Hobson’s choice in November: Bernie
Sanders or Donald Trump. Mrs. Clinton assured him there was no reason for him
to harness up. She would be the Democrat nominee. Republicans remained silent.
They know that an independent run by Mr. Bloomberg would do more harm to the
Democrat contender than the Republican. Mr. Bloomberg ran for Mayor as a
Republican and is now an Independent. But he had been a life-long Democrat. It
is where his sympathies lie.

History is replete
with third parties, from the Anti-Masonics and Free-Soilers during the first
half of the 19th Century to the American Independent and Reform Parties in the
second half of the 20th Century. In 1860, Abraham Lincoln was the first man to
run for President as a Republican, effectively making him a third party
candidate. He won against three others, garnering 39.6% of the popular vote.
But apart from Lincoln, over the past 150 years no third party candidate has
ever won 30% of the popular vote. Theodore Roosevelt, as the Bull Moose
candidate in 1912, came closest, garnering 27.4 percent. Eighty years later,
Ross Perot received 19% when he ran on the Reform Party in 1992, but he
received no Electoral College votes. Third party candidates Robert LaFollette
got 16% in 1924 and George Wallace, 10% in 1968.

Third party
candidates have been, however, spoilers. In 1912, Roosevelt’s entry cost
William Howard Taft re-election. In 1924, Calvin Coolidge won, in part, because
LaFollette’s candidacy took votes from John Davis. In 1968, George Wallace siphoned
off southern Democrats, and Hubert Humphrey lost to Nixon. And, almost
certainly, Ross Perot’s run in 1992 cost George H.W. Bush re-election. Mayor
Bloomberg may face one other historical impediment: No modern mayor of New York
City has gone on to higher office.

Nevertheless, the
Presidency of the United States - the most powerful position on earth - is a
big prize.The prospect for historical
immortality is seductive. Mr. Bloomberg has a good-sized ego and is worth north
of $30 billion. And, perhaps most important, his political philosophy (apart
from a preference for “nannyism) tends to be centrist. His ties to Wall Street
would provide fodder to negative populist rhetoric, but he is a self-made man,
a “doer” with vision. He may think this is his time. At the age of 73 (he will
be 74 next week), this would be his only shot. (Ronald Reagan, at 69, was the
oldest man ever elected President, and he was five years younger than Michael
Bloomberg would be.

There are, in my
opinion, flawed candidates in both Parties, beyond Senator Sanders and Mr. Trump.Mrs. Clinton comes to mind, with her deliberate
decision to store her State Department e-mails on a private server, her lies
regarding Benghazi and myriad scandals reaching back into the 1980s. Ted Cruz
is not deemed collegiate by his Congressional colleagues. It says something
about his character that not one of his Senatorial brethren have endorsed him. Being
able to get along is a lesson Americans should have learned from the incumbent.
Democrats have a limited menu off of which to choose. But Republicans have viable
alternatives: Governors Jeb Bush, John Kasich and Chris Christie are
experienced and competent. While faults can be found in all of them, I would be
happy with any. My favorite, however, is Senator Marco Rubio. His youth is
countered by sensible judgment and good character. He is energetic, smart, and
liked and admired by is colleagues - and he is the Republican candidate most
feared by Democrats.

Democrats, on the
other hand, could be in a tough spot. Most do not want a 74-year old Socialist
and there is risk – perhaps low – that Mrs. Clinton could be indicted. While
Democrats work hard to portray inclusiveness, in fact they have a shallow
bench. The age of their candidates (now that O’Malley is out of the race),
including potential ones, suggest a Party more comfortable with the past than
the future. The Obamas and the Clintons are not close, but if Mrs. Clinton
becomes the standard bearer, the President will stick with her. But if her
legal problems worsen, Mr. Obama may look elsewhere. Joe Biden and Elizabeth
Warren are obvious possibilities, but both have imperfections. Mr. Biden is
older, without the freshness of Bernie Sanders. Mr. Obama could turn to his
kindred spirit, Elizabeth Warren, but he may want a more attractive
alternative. Ms. Warren has lied about her past in order to advance her career.
If you recall, she claimed to be of Cherokee heritage. (See the piece I wrote
on November 9, 2012, “Pocahontas Goes to Washington.”[1])
She is also on the extreme fringe of the Left. As well, she is not young. She
will be 67 in June - old enough (but not wise enough) to be Marco Rubio’s
mother.

Mr. Obama is
determined that his legacy not be at risk, which could happen should Republicans
gain the White House and keep the Senate and the House. The inevitability of
Hillary’s coronation now seems not so inevitable. President Obama has kept his
options open. He has not said whom he would support. This is where Michael
Bloomberg could step in. Keep in mind, Mr. Bloomberg had been a life-long
Democrat before running for Mayor in 2001 as a Republican. That year the
Democrat field was crowded with aspirants wanting to succeed Rudy Giuliano.
Michael Bloomberg, always a pragmatist, correctly thought it would be easier to
win the nomination against former Congressman Herman Badillo, then a
62-year-old former Congressman, than to compete for the Democrat nomination
against a field of a half dozen. In 2005, after winning re-election, he switched
his registration to Independent.

Perhaps it is only
wishful thinking, but my guess is that Republicans, in the end, will nominate a
candidate with broad appeal - an individual who exudes optimism, and whose
policies will give business the confidence to invest in the future and give people
the confidence that, with the right education and incentives, they can create
their own destinies – a person who recognizes that government is necessary, but
should always be subordinate to the rights of individuals. There is no one on
the Democrat slate who can do that. Mr. Sanders beliefs imply a state that
supersedes the individual. Mrs. Clinton has abandoned the more centrist views
of her ethically challenged husband for the more radical views espoused by Mr.
Obama and Mr. Sanders. If Democrats hope to keep the White House, they will
have to find someone with broader appeal. Michael Bloomberg might be that
person.

Perhaps it is
already too late, but if I were a member of the Democratic National Committee,
I would be nervous regarding my prospects, especially if Mr. Rubio is
nominated. I would look upon Mr. Bloomberg as a possible savior. As a
competitor he would be formidable, but not necessarily unbeatable by the right
Republican. His “nannyism”, for example, is troubling. But he would be an
attractive candidate, with generally centrist views. It is curious that the
possibility has received so little attention.